Congratulations! You Can Now Trade for Free!
Did you hear the big news this week?
On Tuesday, Charles Schwab announced the company is eliminating commissions for online trading of U.S. and Canadian stocks and exchange-traded funds (ETFs).
That’s right. Now when you purchase or sell a stock or ETF in your Schwab brokerage account, you’ll no longer get stuck with a $4.95 transaction fee.
The move is effective October 7th.
And even better…
Not to be outdone, TD Ameritrade and E*Trade quickly followed up Schwab’s announcement by cutting their own commissions down to $0. And TD’s move went into effect on Thursday.
Take that, Schwab!
But these moves raise some serious questions…
Like why would an online broker voluntarily cut its commission fees down to $0? Can these businesses survive while charging customers nothing to trade? And why the heck was I paying commission fees in the first place???
Read on below for the answers…
First, Here’s a Little History on Trading Commissions
For nearly 200 years, the New York Stock Exchange (NYSE) charged a fixed commission for all trades.
With some minor exceptions, it cost the same amount to trade 100 shares as it did to trade 100,000 shares. Any brokers who tried to skirt this rule ran the risk of being expelled from the exchange.
This pricing naturally put retail investors at a disadvantage in favor of large institutional clients that took advantage of their economies of scale.
That is, until May 1st, 1975 when the Securities and Exchange Commission (SEC) abolished fixed-rate commissions and replaced them with negotiable commissions.
For the first time, NYSE brokers were allowed to set their own prices to attract customers.
Capitalism was restored and small-time brokers like Charles Schwab were able to compete with the once all-mighty Wall Street banks. It was a massive win for retail investors.
It’s important to note, too, that this was at a time when to place a trade you had to call up your broker, who would in turn write your order on a ticket, which would then be handed to an errand boy, who would then run it down to a designated floor trader, who would then motion a series of complex hand signals indicating you wanted to buy or sell a certain stock.
For this a couple bucks in commission seemed fair for all the effort.
Fast forward to today, and this process isn’t nearly as labor intensive.
Thanks to technology, trading is all done with the click of a mouse and costs brokerages like Schwab virtually nothing.
In fact, most brokerage companies (if not all) actually sell your orders to trading firms who then execute the order on your behalf. Meaning Schwab, TD Ameritrade, etc. actually profit every time you make a trade!
For this a $5-$10 commission definitely isn’t fair. And it’s about time someone did something about it.
Poor Mr. Schwab. Will His Company Survive?
While commissions have slowly been decreasing for decades, investors of Charles Schwab Corp. (SCHW), E*Trade Financial Corp. (ETFC), and TD Ameritrade Holding Corp. (AMTD) still didn’t take kindly to the news of them being cut to $0.
These stocks have gotten crushed in the wake of Tuesday’s announcements, with TD Ameritrade falling the furthest.
So how will these companies fare going forward?
Believe it or not, online brokers have been preparing for this moment for years. And these commissions now only account for a fraction of these companies’ total revenue.
For TD Ameritrade, these fees accounted for 36% of 2018 revenue (a relatively large portion and hence why its stock fell the furthest). But for Schwab and E*Trade, these commissions only accounted for 7% and 17% of 2018 revenues, respectively.
The biggest chunk of revenue for these companies actually comes from net interest, which is the money they earn on the cash you have sitting idly in your account, and fees from asset management.
For Schwab, these streams account for 61% and 28% of revenues, respectively, which makes the loss in trading commissions seem like small potatoes.
And now that commissions are cut to $0, the thinking is that more dollars will soon be flowing into brokerage accounts, which could help boost these revenue streams even higher.
So sure, these companies are initially set to lose a combined couple hundred million dollars in revenue a year…
But the writing has been on the wall for years. And these companies have been slowly pivoting their businesses to reflect that.
Bottom line: The multi-billion dollar businesses that have been overcharging you to trade for years will be fine.
More importantly, this week’s announcement was ultimately a win for retail investors like you and me.
The barrier to investing just got even lower. And the cost you pay when you buy a stock now accurately reflects what it costs your broker to execute the trade on your behalf — $0.
Here’s to keeping your edge,
Managing Editor, The Daily Edge